Here we go into detail on the most powerful binding element in the stock wage world – RSU.
Motivate key employees in both good and bad times
Options usually have an vesting period, as well as an expiration date. The employee must exercise the option in the period between the vesting date and the expiration date. The option also has an exercise price (also often called a redemption price and strike), which is a pre-agreed price for which the shares can be purchased. It is usually a condition that the employee works in the company from the option is granted until an vesting date (vesting date) in order to have earned the right to the option. This means that the participant as a general rule does not lose the option if he / she quits after this. The employee can exercise this right from the time of vesting until the options expire.
A Restricted Share Unit – or promise of a free share sometime in the future – is a type of share pay.
A Restricted Share Unit (RSU) can be seen as an option with a redemption price of zero (possibly only the nominal value of the share), which means that the right to receive the shares is granted upon entering into an agreement. However, the shares cannot be disposed of until they are transferred to the employee on an agreed date. This means that the RSU has all the same elements as an option, but that where the option loses its incentivizing effect in a weak market, the RSU will maintain its motivating effect because it remains «in the money». As long as the company has a certain value, an RSU will in any case have a certain value at redemption.
Before the major financial scandals in companies such as Enron and WorldCom in the United States in the mid-2000s, stock options were the preferred form of stock pay. The scandals and several cases of tax fraud led companies to consider other types of share pay that could contribute to recruitment and retain employees. RSUs became especially popular. These had previously been reserved for management, and were now assigned to employees at all levels.
We consider RSUs to be good instruments when your main point is to attract or “tie in” key employees over a long period of time. RSUs are received regardless of how the company does it and there are no specific goals related to the earnings other than remaining in your position.
Much of the criticism directed at RSUs is that this can be considered a “free lunch”, and shareholders often like that programs are more closely linked to the company’s or person’s performance.
The administration costs for the employer are minimal as there are no actual shares to follow. And because the shares are not to be allotted before the redemption date, a dilution of the shares is also postponed.
A little about taxes
- Upon redemption, a ‘fair market value’ is set – typically the share price at the time of transfer of the shares. They are then counted as salary, and the value of the RSUs received is taxed as salary. This means that if the share price at the time of transfer is NOK 100, and you tax 40%, then NOK 100 will be reported as salary and NOK 40 will be your “tax bill”.
- It is also possible to withhold a portion of the shares to cover income tax.
In both of the mentioned alternatives, the shares received can, as a general rule, be traded freely.
Benefits of RSU's
- Unlike options that can expire without any value, RSUs will always have a value based on the underlying stock. This makes the instrument a super mechanism for making sure your key resources have a big upside in staying, and a potentially big downside in quitting.
- RSUs are risk-free and taxed, meaning there will be no taxation before the redemption date. They provide perceived value even when the share fluctuates in value, and do not involve any pre-investments for the employee or the company.
- The fact that RSUs, as options, are nothing more than an agreement before they become an actual share, makes it administratively efficient to administer. There is no need for a structure for share accounts etc. before the RSUs become actual shares (note, however, accounting management under IFRS).
Disadvantages of RSU's
- No downside for participants (can then be considered a disadvantage among owners).
- No performance elements beyond staying in position.
- Income tax for participants (and employer’s contribution for the company) on the value at the time of transfer. Given good share price development, it would be tax-advantageous to transfer the share earlier.
- In scenarios where the share price rises significantly, RSUs will give a lower gain than with options, as you typically receive more options than RSUs.
- As a general rule, no voting rights during the period the instrument is an RSU.